Tuesday, December 13, 2005

Free trade isn't fair II

Here's a few more words on free trade to add to the earlier discussion. They're made with little empirical verification, let's call it an heuristic of principles.

1) People are one of the major resources in an economy.2) By opening barriers to trade, people (particularly the poor) are fully exposed to fluctuations in the global economy.3) This creates macroeconomic instability, diminishing investor confidence in the country due to uncertain expectations.4) This uncertainty impacts negatively on consumer confidence, hampering economic progress.5) More importantly, it leads to diminished well-being for people at the bottom of the distribution. The result is social dislocation, further hampering development efforts.

For illustration of (5), one need look no further than the UK, where the prosperity associated with the freeing up of markets in the 17th and 18th centuries puzzled and alarmed contemporary intellectuals. Of course, the persistence of the market system eventually dramitcally raised the living standards of all but not without considerable strain on society in the mean time. In economic terms, social capital was greatly diminished.

We saw the same process in the 1980s when Thatcher's reforms, while celebrated now, wrought havoc on the most vulnerable people in society. Britain still has the second highest inequality of the EU15, one of the highest levels of poverty and the lowest levels of social mobility, all of which can be attributed diminished social capital. To this I would add productivity: people suffering from a break down of community relations are, in general, less responsive to education*, mostly due to lack of incentives for improvement.

Other examples are not hard to find, this blog gives an excellent example from the perspective of AIDS workers in South America:

"Free trade agreements (FTAs) such as CAFTA and AFTA , while purporting topromote liberty and free enterprise, erode the infrastructure necessary forbasic health care and development. The pharmaceutical patent-related provisionsof these FTAs reduce the safeguards in place (by the major internationaltrade/intellectual property law, TRIPS) for promoting public health, effectivelyblocking access to and use of affordable ARVs in Latin America for those whoneed them most."

If those that espouse free trade arguments feel that AIDS will not affect the economy, their economics needs a little amending.

Electorates are often derided for squealing about the freeing up of trade when actually it is the result of rational economic choice. If we accept that social stability is the bedrock of its macroeconomic counterpart, unbridled free trade doesn't seem so economically desirable after all.

*This statement comes with the necessary caveats. There is formal and anecdotal evidence that a large proportion of successful entrepreneurs come from difficult backgrounds.

To an extent you're right but note that social mobility rose after the second world war and diminished after Thatcher's reforms. A recent study (can't find link) showed a marked decline in mobility between those born in 1950 and those in 1970.

FluffyI have no idea why you call yourself an economist, since economics rarely makes an appearance in your blog. You’ve got a lot wrong in this post so I’ll try to be succinct. Trade reduces, not increases, volatility in an economy. Given uncertainty in all production, the question is how to deal with it. Consider a country that does not trade and which suffers a bad crop. People starve. A country that trades can import food until conditions improve. Risk shared by trade is risk reduced. The connection between consumer confidence and welfare of the poor is unclear and needs to be explained. I thought both investor and consumer confidence is something business, in particular durables producers, were affected by, not consumers. Economic progress is ultimately caused by innovation not consumer confidence.My reading of your essay is that markets raise income and living standards in the long run but cause short term community pain. If that is a correct reading of your view, shouldn’t you be accepting trade and Thatcher-type reforms as desirable and instead proposing ways to manage the transition for those most affected?The AIDS example is a red herring. The issue is protection of IP. It makes no sense to erect barriers to trade in, say, grain or rice in the hope that IP protection will improve as a side-effect. Better to, er, improve IP protection.Your last paragraph implies macroeconomic performance is improved by limiting trade. How does this square with the overwhelming empirical evidence that countries that trade have higher incomes and living standards, and countries which do not are worse off? (Wolf 2004 has a ton of evidence on this) Also, in view of currently low unemployment, how does limiting access of the poor to low cost imported goods help them?

The fluctuations you refer to as (2) are a once & for all effect of hitting the real world head on. There is no intrinsic reason for the world economy to fluctuate more than a national one & indeed because it is much bigger any single effect is likely to be dampened. Thus, in the long term, on open economy is more stable.

Neil, I have come to see this as the truth, except in circumstances where global prices for a commodity spike. If this occurred domestically, the government could manage prices to lessen the adverse welfare effects of rapid price adjustment. I still feel that some trade barriers are needed to dampen these effects.

Matt B said that the rapid lifting of trade barriers should proceed with government support for those affected by the sectoral reallocation. I have three problems with this: 1) Targetted benefits often exclude many of those they are trying to help, or include many who don't need the help - making them inefficient whichever you look at it. If the problem can be solved at root (ie by slowing the effects of foreign competition by keeping some level of protection in place), such misallocation can be avoided.

2)The sectoral reallocation of labour that (it is hoped) arises exposing markets to foreign competition is not a smooth process, as labour is not perfectly mobile. Unemployment results. This leads firstly to a loss of human capital as skills atrophy and secondly to a ballooning of government spending as it forks out more benefit. To raise money, governments tax businesses thus slowing investment and overall growth and decreasing total welfare, disappointing those with sympathies at any end of the political spectrum. A more gradual approach would avoid such a situation.

Of course, the process of transition could be too slow, safeguarding jobs but slowing growth to such an extent that welfare is ruined for all, but that's where the people with more letters after their name than me come in to work out the correct speed.